Saving in a 401(k) plan is one of the best ways to accumulate wealth for retirement, and while not every worker has access to an employer-sponsored plan, those who do have a real opportunity to build a solid nest egg. In fact, the average contribution to a 401(k) in 2018 was $8,788, according to Schwab's 2019 401(k) Participant Survey.
That's certainly a respectable amount, and it's more than the current limits for IRA contributions ($6,000 for workers under 50 and $7,000 for those 50 and over). Still, it's well below what the contribution limits were for 401(k)s last year. In 2018, workers under 50 had the option to contribute up to $18,500 to their 401(k)s, while those 50 and older could put in up to $24,500.
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If you're in the habit of saving some money in a 401(k), you're doing a great thing for your retirement. Still, it pays to think about how maxing out a 401(k) could change your future financial picture.
Hitting that max
The annual contribution limits for 401(k)s tend to rise over time, and this year's limits are $19,000 for workers under 50 and $25,000 for those 50 and over. Now clearly, hitting these limits is no easy feat. But if you're willing to make some lifestyle changes to eke out more money for savings, you might change your retirement picture in a very positive way.
Let's assume that you're 40 years old with the goal of retiring at 67. If you were to set aside $8,788 annually in your 401(k) over the next 27 years and invest that money at an average annual 7% return (which is a couple of percentage points below the stock market's average), you'd add about $655,000 to your nest egg. That's certainly a respectable sum.
But watch what happens when you max out over the next 27 years instead. Assuming 401(k) contribution limits stay where they are today, you'd boost your nest egg by $1.6 million with that same 7% average annual return. That, in turn, could spell the difference between living it up in retirement versus living a decent, albeit modest, lifestyle.
Of course, living it up in retirement may not be your goal, in which case you don't need to push yourself during your working years to make that happen. But if your vision of retirement involves extensive travel, a country club membership, and many nights out on the town, then maxing out your 401(k) could be just the thing that allows you to experience that lifestyle.
How can you go from contributing an amount that's closer to last year's average to maxing out? For one thing, cut back on existing expenses. If you don't need such an expensive car, trade it in for a cheaper one. If you're starting to loathe the idea of maintaining a large home, downsize to a smaller one that's less costly to keep up with. If you write out a budget, chances are, you'll see at least some expenses in there you can reduce, and the more you're willing to cut back on, the more cash you'll free up for your nest egg.
Additionally, you might consider getting yourself a side hustle to drum up extra money. Of the millions of Americans today who work a second gig, 14% do so for retirement savings purposes.
Let's be clear: Saving $8,788 for retirement annually is a respectable move, especially if you're an average earner. And in many cases, setting aside that much money on a yearly basis will be more than enough to allow you to retire in comfort. But if your picture of retirement is filled with loftier goals, then it pays to do what you can to get closer to maxing out. On the other hand, if your annual 401(k) contributions are nowhere near that $8,788 average, it may be time to start ramping up, whether by reducing your living costs, getting a second job, or both. Otherwise, you'll risk the opposite scenario -- being cash-strapped in retirement and winding up miserable as a result.
